ARRA Is Not Crowding Out Private Investment

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Brian Riedl attempts to respond to critics of his “stimulus can’t work” argument, by basically doubling-down on the money doesn’t grow on trees theory:

Matt Yglesias argued that, during a recession, government spending can put unused resources to work. The problem is that, even in a recession, the spending must be financed by borrowed dollars that would have otherwise been employed elsewhere in the economy. Congress can borrow $10 million from the residents of Anytown to re-open an idle factory in Flint, Michigan. But this leaves Anytown’s residents with $10 million less to spend, which (by the same logic) will cause the idling of resources there. So rather than create new economic activity and multiplier effects, the stimulus has merely transferred them to a new town (my report covers the case of foreign borrowing as well).

Not really, though. This would be true if both the supply and velocity of money were constant, but they’re not. We can empirically examine the interest rate the government needs to pay to examine whether government borrowing is crowding out private investment. Here’s twenty years’ worth of data:

treasuryyield 1

In the early nineties, high government interest rates—the legacy of Ronald Reagan’s massive deficits—plausibly were crowding out private investment. This is why at the time there was a lot of focus on deficit reduction from sensible policymakers. Given that the government is borrowing a lot of money right now, and also that the baby boomers’ retirement and continued growth in health care costs are going to put a lot of stress on future government spending, it’s very plausible that at some point in the not-too-distant future we’ll be in that situation again. But right now we are not in that situation. Many resources are laying idle throughout the country. In principle, private investors could engage in the spending that would mobilize those resources. But they’re showing very little inclination to do so. So the government both can and should engage in deficit spending to try to ensure that the resources are mobilized.

Brad DeLong observes that in an earlier paragraph Riedl acknowledges the logic of stimulus:

Income, by definition, results from productive activity. When productivity increases (thus increasing employment and eventually wages), income increases and demand increases, all in tandem.

Precisely so. Sitting on your couch checking the classified pages for jobs is not productive activity. Having a “retail space for lease” sign in the window of your building is not productive activity. Idling your factory for two shifts a day is not productive activity. Fiscal stimulus aims at reducing the quantity of idling and increasing the volume of productive activity.

I suspect that conservatives would see the logic of this very clearly if, faced with a giant recession, a conservative president enacted a gigantic, deficit-financed temporary tax cut. In normal times this would be bad policy (though conservative think tanks would defend it anyway, as they did in 2001) since the extra borrowing involved would crowd-out private activity. But in a major downturn, it would be helpful policy (though by no means optimal) since it would encourage idle resources to be put to use.